Naive diversification
Encyclopedia
Naïve diversification is a choice heuristic
(also known as "diversification heuristic"). Its first demonstration was made by Itamar Simonson
in marketing
in the context of consumption decisions by individuals. It was subsequently shown in the context of economic and financial decisions. Simonson showed that when people have to make simultaneous choice (e.g. choose now which of six snacks to consume in the next three weeks), they tend to seek more variety (e.g., pick more kinds of snacks) than when they make sequential choices (e.g., choose once a week which of six snacks to consume that week for three weeks). That is, when asked to make several choices at once, people tend to diversify more than when making the same type of decision sequentially.
Subsequent research replicated the effect using a field experiment: on Halloween
night, young trick-or-treaters were required to make a simultaneous or subsequent choice between the candies they received. The results showed a strong diversification bias when choices had to be made simultaneously, but not when they were made sequentially.
Shlomo Benartzi and Richard Thaler
commented on Read and Loewenstein's research: "This result is striking since in either case the candies are dumped into a bag and consumed later. It is the portfolio in the bag that matters, not the portfolio selected at each house." Following on the naive diversification showed by children, Benartzi and Thaler turned to study whether the effect manifests itself among investor
s making decisions in the context of defined contribution saving plans. They found that "some investors follow the '1/n strategy': they divide their contributions evenly across the funds offered in the plan. Consistent with this Naïve notion of diversification, we find that the proportion invested in stocks depends strongly on the proportion of stock funds in the plan." This finding is particularly troubling in the context of laypersons making financial decisions, because they may be diversifying in a way that is sub-optimal.
Heuristic
Heuristic refers to experience-based techniques for problem solving, learning, and discovery. Heuristic methods are used to speed up the process of finding a satisfactory solution, where an exhaustive search is impractical...
(also known as "diversification heuristic"). Its first demonstration was made by Itamar Simonson
Itamar Simonson
Itamar Simonson is a professor of consumer psychology, decision making, market research, and marketing management. He is known for his work on the factors that determine the choices that buyers make. He is the Sebastian S. Kresge Professor of Marketing in the Graduate School of Business, Stanford...
in marketing
Marketing
Marketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...
in the context of consumption decisions by individuals. It was subsequently shown in the context of economic and financial decisions. Simonson showed that when people have to make simultaneous choice (e.g. choose now which of six snacks to consume in the next three weeks), they tend to seek more variety (e.g., pick more kinds of snacks) than when they make sequential choices (e.g., choose once a week which of six snacks to consume that week for three weeks). That is, when asked to make several choices at once, people tend to diversify more than when making the same type of decision sequentially.
Subsequent research replicated the effect using a field experiment: on Halloween
Halloween
Hallowe'en , also known as Halloween or All Hallows' Eve, is a yearly holiday observed around the world on October 31, the night before All Saints' Day...
night, young trick-or-treaters were required to make a simultaneous or subsequent choice between the candies they received. The results showed a strong diversification bias when choices had to be made simultaneously, but not when they were made sequentially.
Shlomo Benartzi and Richard Thaler
Richard Thaler
Richard H. Thaler is an American economist and the Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business...
commented on Read and Loewenstein's research: "This result is striking since in either case the candies are dumped into a bag and consumed later. It is the portfolio in the bag that matters, not the portfolio selected at each house." Following on the naive diversification showed by children, Benartzi and Thaler turned to study whether the effect manifests itself among investor
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s making decisions in the context of defined contribution saving plans. They found that "some investors follow the '1/n strategy': they divide their contributions evenly across the funds offered in the plan. Consistent with this Naïve notion of diversification, we find that the proportion invested in stocks depends strongly on the proportion of stock funds in the plan." This finding is particularly troubling in the context of laypersons making financial decisions, because they may be diversifying in a way that is sub-optimal.